Big Questions for Small Biz

Studies offer guidance for entrepreneurs' start-up dilemmas.

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No matter what the Donald may say, no one thinks it's easy to start a business. From finding early-stage financing to working out the kinks of product development to picking a steady management team, an entrepreneur's dilemmas come fast and furious—and from every conceivable direction. A series of new studies in the Journal of Business Venturing offers some guidance for small-biz owners buried by an avalanche of choices:

• It's one of the first questions facing entrepreneurs when they finally have a handle on their business models. What is the best way to get start-up financing: a bank or—much sexier—a venture capital firm? A study appearing in the journal's November issue argues that banks may not have the sex appeal of VCs but that they do come with certain benefits. Foremost among them: allowing managers to keep financial control over their companies.

Venture capital has its perks, too, and VCs can offer valuable managerial advice to a young start-up. But in Financing Entrepreneurship: Bank Finance Versus Venture Capital, Jean-Etienne de Bettignies and James Brander of the University of British Columbia argue that entrepreneurs looking for the most efficient incentive system should still opt for a bank. By forcing small-business owners to cough up partial ownership of their companies, the authors say, VCs actually decrease an entrepreneur's incentive to work harder. The more you work for a venture capitalist, in other words, the harder you have to work for a venture capitalist. Your share of the company never gets any bigger.

• You've built your business from the ground up, and products are starting to fly off the shelves. Then you get the bad news: Pirated versions are selling on eBay. Time to call the lawyers, right? Not so fast, says a paper appearing in the journal's January 2008 issue, which argues that piracy might actually be a good thing for your company.

In Can Entrepreneurial Firms Benefit From Product Piracy? a group of scholars from the Instituto de Empresa in Spain, the University of Colorado-Boulder, and Indiana University make the case that while piracy certainly damages the individuality of a particular brand—which never helps the bottom line—it can ultimately have positive long-term effects on a product's value.

Too many managers, the authors say, become obsessed with piracy's effect on sales, without appreciating its silver lining: increased exposure, the expansion of "bandwagon effects," and, in many cases, improved overall demand. The authors point to one telling example, a 1995 study of the software industry, which found that 6 out of 7 software users had pirated software. Instead of destroying the industry, though, pirates actually helped it: By expanding the pool of software users, they were responsible for generating more than 80 percent of the buyers of legal software. (Memo to recording-industry execs: Eat your hearts out.)

These findings have important implications for small-business strategy: While most entrepreneurs try to defend their intellectual property rights on all fronts, the authors maintain that IP should be dealt with differently in different markets. The more mature the market, the higher the cost of piracy.

• Founders of businesses tend to infuse their companies with their own small-scale cults of personality. They are their company's visionary, its public face, its organizational influence, and, often, its primary owner. Still, studies show that between a third and a half of businesses that go public do so with a CEO who is not the founder.

Why is this? In Factors Influencing the Choice Between Founder Versus Non-Founder CEOs for IPO Firms, Bharat Jain and Filiz Tabak of Towson University examine which characteristics make or break a small-biz owner's chances of becoming CEO. Studying a sample of 630 firms that went public in 1997, the researchers find that founders with "functional backgrounds" like marketing or product development are much more likely to continue as CEO than those with skills more focused on efficiency, like engineering or accounting. Interestingly, younger founders also have a greater likelihood of being the CEO through an initial public offering than older founders, probably, the authors say, because they are perceived by investors to be less risk-averse—and more likely to generate high growth.

The larger the founding team, the greater the chance a founder has of being CEO. Same goes with the number of insiders on the company's board. Not surprisingly, relying on venture capitalists comes at a high price in this area, too: The greater the role of venture capitalists in an IPO, the smaller the chances a founder has of continuing to run his own company.